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This Is the Best Way to Fix Social Security, New Analysis Shows

After examining a multitude of tax and benefit provisions, the Penn Wharton Budget Model reaches a surprising conclusion.

This may come as little shock to many of you, but Social Security is in some pretty big trouble. Since 1985, the annually released Board of Trustees report has estimated that the program had insufficient revenue generation to cover beneficiary payouts, inclusive of cost-of-living adjustments (COLA), over the long run, which is defined as the next 75 years.

Due to a number of ongoing demographic changes, such as the retirement of baby boomers from the workforce, the long-term lengthening of life expectancies, growing income inequality, and more recently, persistent declines in fertility rates, there simply won't be enough revenue coming into the program to sustain the current payout schedule. The Social Security Board of Trustees has forecast that the program's nearly $2.9 trillion in asset reserves will be depleted by 2034 as a result of net cash outflows from the program (set to begin soon), with an across-the-board benefits cut to follow of up to 21%.

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Social Security's problems may be worse than you realize

But what you may not realize is that some analysts view Social Security's situation to be even direr than what the Trustees report has presented.

This past August, The Penn Wharton Budget Model (PWBM), a nonpartisan, research-based initiative that analyzes the fiscal impacts of public policy, found the Social Security program to be on far worse footing than initially projected. According to PWBM, the nation's growing debt is expected to "erode the size of the future tax base," which will further compromise cash flow into the program.

With this in mind, PWBM ran an analysis that incorporated a number of future macroeconomic variables, including growing national debt levels, and found a 36% larger cash shortfall by 2032 compared to the Trustees' report, and a 77% larger projected cash flow shortfall by 2048 relative to the Trustees' model. Furthermore, the PWBM model forecasts that national debt-to-GDP ratio will top 200% by 2048, which wouldn't be sustainable for very long.

Regardless of which model you prefer to follow, they both agree that Social Security's current income stream won't be sufficient to maintain the existing payout schedule for too much longer without (1) additional revenue, (2) expenditure cuts, or (3) some combination of the above two measures. Though this seems pretty simple and straightforward, finding a resolution to Social Security's cash shortfall has been anything but easy.

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There are no shortage of options to tackle Social Security's cash flow issues

Arguably the biggest issue is figuring out how best to tackle the problem. In other words, analysts understand the solutions available, but there's little consensus or understanding on how those options would impact the program and/or economy over the long run. Thanks to a newly released analysis from PWBM, we now have that answer.

Earlier this month, the PWBM released its newest analysis on Social Security's long-term outlook (defined as a 30-year forward-looking model, through 2048) by examining how six options to "fix" Social Security's cash shortfall would hold up against its current path, which the Trustees opine is $13.2 trillion short of cash between 2034 and 2092.

The PWBM analysis to resolve Social Security's cash shortfall tinkered with six variables -- three from the tax side of the equation and three from the benefit side of the aisle. In terms of tax implications, it looked at adjustments to the 12.4% payroll tax rate on earned income, the maximum taxable earnings cap, and introducing a payroll tax on high income earnings above a certain "donut-hole" figure, which in this instance was $250,000. As for benefit provisions, it examined changes to how COLA is measured, made adjustments to the primary insurance amount, and analyzed changes to the full retirement age. You can see all of these options in Table 1 of the PWBM analysis.

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This is the best way to fix Social Security

So, which combination of policy changes worked out best? Interestingly, all six options improved GDP growth over the long run more than the current model. But in terms of long-term GDP growth, Option E proved to be the best. Here's what Option E entails:

Increases the full retirement age to 70 (currently set to peak at 67 for those born in 1960 or later)

What stands out about this optimal fix? Well, don't fall over, but it's bipartisan. What PWBM found out was that tax revenue increases and benefit reduction were both needed to help offset issues that Social Security is contending with.

For example, the model notes that tax revenue increases, such as lifting the earnings tax cap, creates an immediate increase in revenue. However, it also points out that the donut-hole tax, which wasn't included in the "best" option, tends to reduce labor supply and coerce the rich to get creative with their income generation. PWBM notes that some well-to-do persons may defer income realization or derive their income from small businesses to avoid a higher tax rate. In short, raising taxes works quickly to address the cash flow shortfall, but it tends to produce lower long-term economic growth.

Meanwhile, PWBM's newest analysis finds that benefit reductions often move slowly when it comes to addressing the program's cash shortfall, but they do have a positive impact of requiring households to save more for their own retirement. Opposite to tax increases, benefit cuts tend to provide the highest long-term GDP growth.

In other words, the best way to fix Social Security is going to be with a balanced approach that incorporates an increase in taxable revenue, as called for by Democrats, as well as a reduction in long-term benefits, as proposed by Republicans.

Author

A Fool since 2010, and a graduate from UC San Diego with a B.A. in Economics, Sean specializes in the healthcare sector and investment planning. You'll often find him writing about Obamacare, marijuana, drug and device development, Social Security, taxes, retirement issues and general macroeconomic topics of interest. Follow @TMFUltraLong